Stanford’s Taylor Says World Is in Good Shape

The world looks pretty good to John Taylor, Stanford economics professor and former undersecretary for international affairs at the U.S. Treasury.

John Taylor

Mr Taylor — who came up with the simple, ubiquitous rule for setting interest rates known as the Taylor Rule – says central banks have learned the lessons of the high-inflation 1970s and are more likely to nip inflation or deflation in the bud. Meanwhile, emerging markets have made their exchange rates more flexible, manage their debt better, and bulked up their reserves. Coupled with the IMF‘s increasing tendency to advise rather than intervene when a country’s having trouble, these changes have kept the world free of financial crises since 2002. “We’re in amazing times,” says Mr. Taylor.

And, as long as policymakers continue heeding those rules, the good times should continue. The U.S. economy, for instance, has turned the corner. In an interview at the Center for Financial Studies in Frankfurt, Germany, Mr. Taylor says he has scrutinized the turmoil in the subprime and housing markets and doubts it will spill over into the broader economy. An uptick in exports is helping offset the housing slowdown, he says, while subprime investors had enough forewarning of the bubble’s burst to shift their assets accordingly, and enough confidence that policymakers would react responsibly not to retreat from unrelated markets.

“So, while there was quite a slowdown in growth in the beginning of the year, it seems to be behind us,” he says, estimating that the U.S. economy will soon return to GDP growth rates around potential, or around 3%

Mr. Taylor, who recently wrote a book on terrorist financing (Global Financial Warriors: The Untold Story of International Finance in the Post-9/11 World) also has praise for Fed Chairman Ben Bernanke, who he says seems to be making the same decisions his predecessor Alan Greenspan would have made. Those decisions, by the way, are keeping interest rates in line with Mr. Taylor’s rule, which recommends higher interest rates when inflation is above target or when the economy is above full employment: “He’s got the interest rate pretty much where I think it should be right now.”

China also gets high marks for its slow, deliberate revaluation of its currency, the yuan. “I think the current policy on the exchange rate is working very well,” says Mr. Taylor, who believes political pressure from the U.S. and Europe to let the currency rise faster is misguided. Faster appreciation could roil the Chinese economy and international markets. “The fact that the Chinese economy’s continuing to do well is beneficial to the U.S. and Europe,” he points out.

Finally, central banks across the globe appear to be doing their job well – by focusing on inflation at home, just as the Taylor Rule stipulates. The rule doesn’t explicitly take global developments into account; there’s no provision, for instance, for exchange rates. But, while globalization might affect domestic inflation by pushing import prices down, for instance – central banks don’t need new guidelines to deal with the change: “Despite the fact that the world is very interconnected, the good policies are the ones that focus on what’s happening domestically. So you don’t even need to think about a global approach if each central bank is focusing on their own inflation rate.” Which, he says, is happening. –Joellen Perry

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